Process costing is used by organizations that can't identify the customer before building the product or service. Instead, these organizations build inventory now that is sold later when customers purchase completed products. Determining the cost of producing a product or service basically involves summing up the costs going into the production process and dividing by the number of units that complete the process. Since organizations using process costing can't track production costs and production output to a particular job or customer, the costs and outputs are tracked to a period of time (a day, a week, a month, etc.).
The challenge with using a period of time to track costs is the problem of partially complete units of work. Organizations with process costing systems need to solve this problem before production costs can be divided by output in order to create cost-per-unit measures needed in accounting and management processes. The challenge of partially complete units of work is handled by using “equivalent units” of production.
Process costing is used by organizations with production processes that make it impractical to identify the customer's product or cost as a “job” during the process. Without a potential customer to target costs moving through the accounting system, the process costing method uses a production period of time to group together costs and output until they are eventually transferred to the finished goods inventory. The challenge in this approach is that there tends to be partially complete products or services at the beginning and/or end of a production period. Dealing with this challenge requires the computation of equivalent units of production.
Cost are then tracked on these equivalent units as they move through the production process. This lesson worked through a series of computations to track costs of goods manufactured and transferred forward, and computations to measure the value of the ending balance in the work-in-process inventory account. Both the first-in-first-out (FIFO) and weighted-average (W/A) methods of process costing were demonstrated.
